‘Climate change is a key driver of financial risk’

RBI’s Rao flags physical, transition risks

Climate change and its impact is increasingly being acknowledged as a key risk driver for the financial system by governments, regulators and financial firms, said M. Rajeshwar Rao, Deputy Governor, Reserve Bank of India (RBI).

“Climate risks can impact the financial sector through two broad channels; first – physical risks which mean economic costs and financial losses resulting from the increasing severity and frequency of extreme weather events and long-term climate change, and second – transition risks which arise as we try to adjust towards a low-carbon economy,” Mr. Rao said in a speech at the CAFRAL Virtual Conference on Green and Sustainable Finance on September 16, a copy of which was posted by the RBI on Monday.

“It is, therefore, important to understand these risk drivers which are likely to affect the financial firms,” he added.

Mr. Rao said physical risk drivers are directly observable and often refer to frequent extreme weather events which inflict direct economic costs and financial losses on financial firms as well as cause a longer-term but gradual shift in climate. Such acute physical risks arise from extreme climate events such as heatwaves, landslides, floods, wildfires and storms.

On the other hand, chronic physical risks are longer-term events as they arise from gradual shifts of weather patterns, he said.

Compliance cost

He said transition risks essentially reflect as compliance cost when one embarks upon adjustment to a low-carbon economy.

“This would include changes in government policies, market and customer sentiments and necessity for technological upgradation. Mandated climate-related mitigation plans could cause decrease in financial valuation or downgrade of credit ratings for businesses which are violating climate norms,” he said.

“Such plans can also cause a shift in market power,” he added.

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